When I talk to people about my new book, Unlocking Private Company Wealth, I tend to talk about success stories where business owners have accomplished good things, or even great things, in terms of managing private company wealth.  I guess that’s natural.

While talking with a client recently, he asked me about cases where things didn’t work out so well for business owners.  Here’s one that I remembered.

The Situation

Ralph came to us a number of years ago.  He owned 100% of a successful private company that had grown rapidly and had been quite profitable.  When Ralph first visited us, his business was doing more than $8 million in EBITDA and had no debt.  We provided some calculations that suggested that the company might be worth $50-$55 million or so, depending on the nature of the marketing process.  We talked to Ralph about marketing his business, but he declined to to anything.  We explained to Ralph that, while his business was doing well, he had significant product concentrations and was subject to emerging competition.

Our thought was that the company was attractive then and could be successfully marketed to one of several larger companies because of its novelty in the field.

Ralph waited for more than three years before coming back to talk to us.

Things Change

When Ralph came back, his company was still doing fairly well, although some of the competitive factors we had noted during our first contact had begun to emerge.  Sales had peaked and begun to decline a bit, and margins dropped a good bit faster.  The company had just completed a year with EBITDA of about $6 million, and Ralph was interested in selling.  We told Ralph that his topside for a potential sales price was on the order of $35 million, and that time was of the essence in getting a transaction going.

Ralph insisted on keeping control of any marketing process, and he limited the scope of any search for buyers.  Given the nature of our engagement, we were able to assist him in negotiating with prospects he identified.  I’ve said many times that “Time wounds all deals.”  Time passed, and passed and passed.  The deterioration in revenues continued, and profitability slipped further.

We finally pulled a deal together for a price of close to $20 million.  It closed, thankfully, because the company likely would have continued to decline in revenues, earnings and value.  The good news is that we did finally find a buyer where the “fit” was so good that they overlooked, to some extent, the decline in the company’s fortunes.  I say to some extent, because we had no competing bidders.

The Cost of Delay

Ralph’s delay from our initial contact and his further dalliance after the second contact cost him $25-$35 million in purchase price.  Chapter 17 of Unlocking Private Company Wealth is titled, “Bad Things Happen to Good Companies.”  Quoting briefly:

If you wait until it is too late to diversify [your private company wealth], it will be too late.

This simple statement is powerfully true.  As optimistic business owners, we tend to think that bad things happen, but to other people.  So we wait to do things we know we should do.  Financing that is readily available today to accomplish diversification objectives may not be available tomorrow.  This can happen because of adverse events at your business, changes in the availability of financing, or both.  Don’t wait.

Ralph didn’t believe us when we spoke of emerging competition.  And he didn’t believe us when we talked about his customer dependence.  Both factors came into play over a relatively short period, and the value of his business was diminished substantially.

The Goal

Let’s move beyond Ralph for the moment after observing that he is a personal victim to the fact “bad things happen to even good companies” and that it was costly for him.

The goal for business owners should be to manage their private company wealth with the same degree of intensity and respect that they accord to their liquid wealth, which is often professionally managed.  This means paying attention to the state of the business and its value trajectory over time.  It means that when appropriate opportunities come along to use reasonable leverage to diversify wealth, it is appropriate to give those opportunities serious consideration.

Business owners sometimes fear taking on any leverage, thinking that leverage is risky.  Think about leverage this way.  If you don’t have any leverage, and your business is healthy and capable of handling a reasonable debt load, you are accepting 100% of the risk associated with the equity in your business.

If you borrow 20% of the value of the business and pay a leveraged dividend, for example, or repurchase shares for a similar amount, then you have diversified 20% away from the business, and reduced your risk to 80%.  The bank or other lender is sharing the risk with you.  They do so at current low borrowing rates, and your cost of capital goes down and your return on equity goes up.

As always, give me a call to talk about any issue related to business valuation or to ownership and management transition.  Sign up for this blog to receive each new post.  And, if you haven’t done so already, buy Unlocking Private Company Wealth for yourself and for your fellow owners.  If you are an adviser, purchase copies for your clients.  Available here and quantity discounts apply.

Until next time,

Be well!

Chris